Sonic Automotive Inc (SAH) 2006 Q3 法說會逐字稿

Good morning and welcome to the Sonic Automotive third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question press star then the number two. If anyone needs assistance at any time during this call please press star followed by 0 and the operator will assist you. As a reminder, ladies and gentlemen, this call is being recorded today Tuesday October 31, 2006. Presentation materials management will be reviewing on the conference call can be accessed on the Company's Web site www.sonicautomotive.com, by clicking on the for Investors tab and checking Webcasts & Presentations on the left side of the monitor.

At this time I would like to refer to the safe harbor statement under the Private Litigation Securities Reform Act of 1995. During this conference call, management may discuss financial projections, information or expectations about the company's markets or otherwise make statements about the future. Such statements are forward looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made. These risks and uncertainties are detailed in the Company's filings with the Securities and Exchange Commission. Thank you. Good morning, ladies and gentlemen.

Welcome to Sonic Automotive's third quarter 2006 earnings call. Joining me on the call today are the Company's Vice Chairman and Chief Strategic Officer, Mr. Scott Smith, and our Chief Financial Officer, Mr. Dave Cosper. The presentation material for this call is posted to our Web site, www.sonicautomotive.com, and can be accessed by clicking on the for Investors tab and choosing Webcast & Presentations on the left side of your screen. Our comments today will be linked to the slides on this site.

We're very pleased with our third quarter results. Once again, Sonic has delivered a solid operating performance despite a difficult sales and interest rate environment. Total earnings per share for the quarter was $0.65 including a stock option expense of $0.01, up 6.5% over last year. EPS from continuing operations was $0.66 a share up 1.8%. Our strategy remains focused on the following. First, the higher margin business segments service, parts, and used vehicles. Secondly, implementing standardized processes and best practices and finally our portfolio enrichment strategy. During the quarter, this helped us achieve an operating profit increase of 11.8% and an operating margin of 3.6%. However, the number that I'm most proud of this quarter is our debt to capital ratio, which has declined 600 basis points from year-end 2005 to 40%. 40% is the target we established over two years ago and I'm pleased to announce the delivery of yet another performance promise. Dave will go into more detail on this later.

Please turn to the next slide. Let me give you an overall breakdown of our operating performance. Total revenues increased 7.5% to nearly 2.1 billion. While all retail segments experienced increases for the quarter the primary drivers of the improvement were strong, same store used vehicle sales and continued improvement in fixed operations. Gross profit was up 26 million or 8.9% and gross margin for the quarter was 15.3% up 20 basis points from last year. New vehicle margins improved 20 basis points and for the second quarter in a row our fixed operations margin achieved the 50% mark. Our F&I per unit retail improved 2.7% or $25 per unit retail. SG&A was 74.7%, down an impressive 90 basis points from last year. Interest expense, however, was up substantially. I'll talk more about this on the next slide.

Please move to slide 3. I wanted to drill down a bit deeper in the third quarter results to highlight our operating performance. As you can see, compared with last year, revenue is up 7.5%, but gross profit is up 8.9%, and operating profit is up 11.8%. We are keeping more gross profit on the revenue we generate and through control of our costs more profit is flowing through to the bottom line. Operating profit is up nearly $8 million from last year. Our head wind, of course, is interest costs. Rising rates rather than higher debt or inventory levels account for essentially all of our $5.6 million increase in interest expense. If interest rates had remained unchanged from the third quarter 2005 levels, net income from continuing operations growth would have been up approximately 12% as compared to a reported increase of nearly 2%. Combine a flat interest rate environment with the elimination of the effect of stock option expense on current year results and the growth rate is over 14%. This demonstrates the strength of our core operations during the quarter.

Next slide, please. Now, let's review our same store performance. Total same store revenue and gross profit were up 2.8% and 4.3% respectively. Total new vehicle revenue was up 2.9% versus third quarter 2005. Our new retail vehicle volume was down just 0.7% compared to an industry decline of 6.2%. Remember, the 6.2% decline does include fleet sales. Same store used vehicle revenue was up 5%. The increase in revenue was driven by the performance of our program stores, which I will discuss further in just a moment. Certified preowned continues to comprise over 1/3 of our total retail volume. Same store F&I revenue was up 4.4% driven primarily by a $39 increase in gross per unit.

We continue to roll out our standard electronic F&I menu and so far the feedback has been very positive. The menu gives the consumer visibility to all of the products available to them resulting in a much more efficient process as well as the potential for better product penetration and greater focus on compliance and transparency. Continuing a string of terrific quarterly results, despite one less service day in the quarter, same store fixed operations revenue was up 5.1% while gross profit for the quarter was up 6%. Of special note, customer pay service sales increased 10.8% and accounted for 80% of our overall fixed operations revenue group.

Please turn to slide number 5 and a review of our used vehicle performance in more depth. While our total same store retail unit sales in used were up 2.2%, our program stores improved volume by 6%. This compares very favorably to the 23.4% decline reported by the national franchise dealers. The bar chart shows Sonic's year over year sales growth compared with the industry. As you can see it's clear that our new processes and program are working. Since the implementation of our program store process, the differential between our same store performance and the national performance has been dramatic. We believe that the lower cost-to-sales segment fills an important consumer need that we have overlooked in the past. Additionally, the timing is right for focusing on this segment. The dynamics for this market are improving, overall unemployment is low, overall credit availability is improving and used FICO scores are on the rise. Presently, we have approximately 60% of our dealers in the used vehicle program. As we communicated last quarter, we expect to have the remaining stores implemented by the end of Q1 2007.

Moving to the next slide. I'd like to take a moment now to highlight the strong fixed operation trends. The investments we've made have yielded dividends as can be demonstrated by an average revenue growth rate over the last five years of approximately 15%. We are very proud of our performance in this area. We continue to drive sales while increasing margin. This is reflected in our record fixed absorption attainment of 89.6% for the third quarter. Our luxury stores reported fixed absorption of over 100% in the third quarter. This growth reflects our dedication to executing on a few key areas over the last several years. Number one, standard sales practices. Number two, sector leading certified preowned and extended warranty sales. Number three, increased stall capacity at targeted dealerships. Number four, our portfolio enriched brand mix, and number five, attention and commitment to customer satisfaction. We believe that this segment of our business remains a significant opportunity and a core strength for Sonic Automotive. Now, I'd like to turn the call over to our Chief Financial Officer, Mr. Dave Cosper to review some of the other strong trends. Dave?

Thanks, Jeff. And I'm on slide 7 now. We continued to make great progress during the quarter on reducing our costs. In total, SG&A as a percent of gross profit was 74.7% down 140 basis points from full year 2005 and down 90 basis points from Q3 2005. Excluding rent expense, SG&A is down 200 basis points to 66.8%. We've made good progress in controlling our compensation costs, advertising and other fixed costs. And for certain of these fixed costs, we've actually reduced the level of spending from last year on top of increasing gross profit. Although rent costs are up, fixed absorption continues to increase and reached 89.6% for the quarter. We're investing in areas that provide solid returns like increased stall capacity and our premium brands. We reduced costs and believe there's more opportunity going-forward especially as we begin to realize the benefits from our common DMS system and continue to roll out our many of our standardized best practices.

We turn to the next slide. This slide talks about our inventory management and during difficult times in the marketplace and when rates are high and rising, it's increasingly important to manage inventory properly. Sonic continues to demonstrate excellent inventory discipline across the board. We ended September with a 44-day supply of new vehicles compared with the industry at 61 days, The BP industry averages for domestic, luxury and import vehicles. Used car inventory ended the quarter with a 33-day supply, below our normal disciplined target of 38. During the quarter we aggressively managed our slow moving inventory in order to put us in a favorable inventory position for the fourth quarter.

Turning to slide 9. We ended the quarter with the debt to capital ratio of 40% and achieved the target we established and communicated a couple years ago. Our debt structure is now consistent with many in our peer group and our entire team is proud of this accomplishment. As I told you on our last call. We plan to reduce our investment in Cornerstone Acceptance our sub prime lending operation. During the quarter we sold nearly $27 million of receivables almost half our total receivable balance. We used the proceeds to reduce our debt. Presently we are in discussions with several parties on strategic options for the business. Success in this area would improve our leverage further and reduce our debt costs. As you know, we've introduced increased discipline around project analysis, return target, and decision making. Improved capital allocation and a stronger balance sheet remain among our top priorities. We believe that a lower level of debt will provide us greater flexibility for future growth. So with that, I'll turn the call back to Jeff.

Thank you very much, Dave. Please turn to slide number 10. The continued execution of our portfolio enrichment strategy helps stimulate the positive trends that we've just reviewed. For the year, luxury and import brands comprised 82% of total revenue compared with 79% a year ago. Luxury brands alone were responsible for 50% of Sonic's total revenues so far for the year. While we are very pleased with the progress made here, we want to point out that for the quarter, our domestic stores performed well and were material in our new vehicle margin improvement. In terms of total revenue, our top brands in the third quarter were Toyota, including Lexus, at 18.9%, General Motors, including Cadillac, at 18.9%, Honda, including Acura, at 16.5%, BMW, including Mini, at 14.8%, and Mercedes-Benz at 8.9%. The strongest regional platforms during the quarter were Texas, Oklahoma and Southern California. We did not close on any major acquisitions during the quarter and year-to-date we've acquired approximately $300 million in annual revenue.

Next slide, please. In summary, we're very pleased with this quarter's results. We continued to deliver on the commitments that we've made to the marketplace. Our overall strategy and operating initiatives that we've implemented over the last 24 months continued to produce the results that we expected. We have consistently driven same store sales growth while reducing costs and improving our balance sheet. The ongoing implementation of our operating best practices has driven our SG&A expenses as a percentage of gross profit to among the best in the sector. In fact, once you normalize for rent expense, and real estate across the peer group, we are the clear leaders in SG&A control. We believe the technology solutions we're currently implementing, such as our standard DMS platform, our electronic menu application, and inventory management technologies, have the potential to drive both future revenue growth and further cost deficiencies.

We are especially pleased that we were able to achieve our leverage reduction target. The sale of a portion of our Cornerstone portfolio along with the continued discipline over our capital expenditures and other cash spending contributed significantly. As Dave mentioned, this will position us well for acquisition growth in the coming year. While we do expect the new vehicle climate to remain competitive, we believe the strength of our brand mix and our underlying operating best practices will help offset the difficult new vehicle environment, therefore, we are reiterating our full year 2006 continuing operations EPS target of 2.05 to 2.15 per share, which includes $0.08 of stock option expense.

Additionally, I always want to recognize the collective efforts of our outstanding Sonic associates. We have the best team we've ever had at Sonic and today's strong reported results are reflection on them. Finally, I want to thank our manufacture partners for their support as they continue to introduce terrific new product and marketing programs. Our dividend will remain unchanged at $0.12 per share, payable on January 15th, 2007 for shareholders of record as of December 15, 2006. At this time we'll now entertain your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Rich Kwas with Wachovia.

Hi. Good morning. This is [David Lindh]. Can you hear me?

Yes. [overlapping voices]

Yes. Hi. Several questions here. Can you explain the decline in used vehicle margins year-over-year, can you provide us a little more color to that?

Yes, I sure can. As Dave mentioned, we made a conscious strategic decision to take our used vehicle inventory down during the quarter. We experienced some demand pressures as noted by the industry declines of almost 20% during the quarter-- or over 20% during the quarter. And we adjusted the pricing at retail on the units that we had in inventory during that cycle. And made a decision that we wanted to carry a very clean inventory into the fourth quarter and mitigate any further pricing risk and ultimately we priced to the market and that resulted in some short term pressure on used car margins.

Great. Thanks. Another follow-up here is on the balance sheet, you reached your 40% debt to capital. Is there another goal out there that you guys are looking into for your balance sheet?

We're certainly thinking about it. I'm feeling much better about our debt position and capital structure. And I would like to keep it in the range, certainly somewhere in the neighborhood of 35% to 40%. It's going to blip around a little bit depending on what we're doing with acquisitions and other spending, but I'm very pleased with the trend.

Great. Can you provide us a little more color on the Cornerstone situation? I mean, you mentioned that you sold off half of it. Any -- can you provide more color on that, please?

Yes, as I reported last quarter, it's a great business. It makes money for us, it really helps us sell used cars, as well, but it's a business we don't need to own. So we're exploring options for it. We were very pleased with pricing we got on the $27 million of receivables, and that helped us free up some cash and pay down debt. And we're exploring options going-forward. And it's going well. Hopefully I'll have something to report on at our next call.

Yes. To follow-up on that on the Q4 call, I mean, do you have like a target on when this thing will wrap up or do you think it's going to prolong into the early part of the first half of '07?

It's great. I'm actually not under any pressure to do anything with this.

Okay.

It's a good business and we'll just see how the negotiations go.

Gotcha. Gotcha. And finally, can you talk about Southern California? People are saying about the mortgage resets, have you seen any kind of pressure there with your stores?

You know, our California trends year-over-year were positive. We had some nice profitability improvement which I would characterize as more of a management phenomena. We did see modest pressure. We were down a few percent in new vehicle volume and about 5% in used vehicle volume in the Southern California area. But we also enjoyed record fixed operations performance, particularly in California, which again drove the strong year-over-year profitability increases.

Great, great, that's all I have. Thank you very much.

Sure.

Your next question comes from the line of Jerry Marks with AutoRetailStocks.com.

Great quarter. I really have one question. Dave, with a lot of the focus on higher ROI's, Group One just on the last conference call said that they're rethinking their approach to leased versus owned? Have you guys made any decisions about whether you'd like to own more versus lease.

I have been giving that a great deal of thought. Personally, for properties and choice spots and our great brand, I would like to own some of those properties outright. I think we -- it's very cost effective. I like having a blend of financing alternatives, so I think I'm going to turn an eye to that very closely in the near term.

Great. Thanks, that's all I had.

Your next question comes from the line of Peter Siris with Guerrilla Capital.

Hi, guys.

Good morning, Peter.

I'm very concerned about the balance sheet here. It looks to me like you're going to in another couple years, going to become a bank. I'm kidding. But I'd like to [laughter ] I'd like to ask a couple of cash flow questions. The CapEx is what again?

Let me flip to this, Peter. For the year, Peter?

Yes.

CapEx, net of sale in lease back will be in the neighborhood of 50 million, 50 to 55. Just following up on Jerry's question if you heard that, on some of this spending we may choose to keep it on balance sheet versus selling it, in the sale and lease back, depending on the favorability of the rates. And so we're going to be looking into some mortgage finance.

Now that you have your debt down, if you would do mortgage financing that would theoretically lower your interest rates? And also give you greater flexibility, right?

Yes, it would.

And if that's -- what's the -- if I look at the depreciation, what's the free cash flow based on what we're looking at now for earnings?

Probably in the neighborhood of 80 to 90 million for the year.

So if -- so the strategy is to reduce the leverage a little more? But still you have a lot of free cash flow that the company is generating, so that either says that you're going to have to pick up your growth rate or you're going to have to do something with the cash, is that a reasonable view?

That is very reasonable and it -- I think Jeff and I both handed in our remarks that we're positioning ourselves for future growth.

And, I mean, when you say you're positioning yourself for future growth, a couple of the other guys have talked about the fact that acquisitions in the luxury import and luxury business have gotten expensive. Are you starting to see more opportunities in those markets?

Well --

Are you starting to see more potential growth opportunities?

They're -- in our view, there are plenty of growth opportunities, Peter. I think if you go back to my comments last quarter, what we are seeing in those premium brand segments is very high seller expectations and so there is a lot of high asking price, but there have only been a handful of transactions that have closed at what I would characterize as pricing outside the normal range, and so it's our view that now that many of the large private and public consolidators have pulled their horns in and shown some universal discipline, that the seller community is going to become more realistic and that, therefore, there will be plenty of opportunities to acquire premium brands within a valuation range which will meet our return targets.

Thank you. I just have -- I have a comment I would like to make, which is, since I've been on these calls in the past, screaming at you guys for various reasons, I just want to compliment you on having delivered for a whole bunch of quarters, five, six quarters in a row now, exactly what you said you were going to do. So thanks.

That's nice to hear, thank you.

Thank you, Peter.

Your next question comes from the line of John Murphy with Merrill Lynch.

Good morning, guys.

Good morning, John.

Hi John.

I have a question on -- to clarify some detail on the mortgage rates versus the cap rates, what are you seeing as a potential, you know, savings out there, what's your mortgage rate, available mortgage rate versus your cap rates on your sale lease backs?

Well, they vary greatly, but I think we're looking at savings of 150 to 200 basis points.

Okay. And then if we think about inventory here in the short run. I mean, clearly it's a big problem for a lot of the other of your competitors, actually and just sort of the dealer base at large. It sounds like you've done a great job at managing the inventory. Is there anything going on with your mix of inventory between '06 and '07 models or are you progressing through the work down on the '06s in a normal manner?

We appreciate you acknowledging the outstanding job that our team has done in managing our inventory with discipline. That's been a core strength at Sonic for many many years, and I think this quarter really validates our process there, because as you noted, inventory has been a problem industrywide. We like where we're positioned in terms of '06s and '07s. We are at about 60 -- excuse me, about 58%. '07 models inventory now. About 41% '06s. And obviously, the OEM's who are under inventory pressure, we believe will continue to incent those '06s. We feel good about having a competitive inventory of '06s to take advantage of that aggressive incentive environment that we look to exist between now and the end of the year. I'll also note that we're about 60% car and 40% truck in our inventory, which we believe also positions us to take advantage of the current trends in the marketplace.

That actually brings up another question. How big is the Delta on your gross per vehicle on a car versus truck? How much does that mix shift have upon you?

If you give us a moment, we'll circle right back to you with a good number there.

Okay.

In fact I've got it here. Obviously, large SUVs versus cars, we've actually enjoyed stronger gross margin in cars significantly better than large SUVs and cars are producing about $350 more margin than a truck. But keep in mind we're 50% luxury. So we're over weighted in terms of our car penetration in luxury, in fact our luxury brands, 74% of our total volume is car versus just 26% in truck. So that skews our numbers somewhat and makes a big impact on that differential between car and truck.

So needless to say, it's actually mid shift, is actually a potentially a negative at the front end of the value chain. It's actually a positive for you here in the short term?

That's correct and I think that our numbers that were reported bear that out. For example, in domestic, we're about 39% car and 61% truck. So having 50% of our brand weighted in luxury obviously gives us a car bias and as I just reported our margins are much stronger in car than large SUV. In fact they're almost double. And there are a few hundred higher than a conventional truck model.

One last question on your service base. I mean, what's your current capacity utilization rate in your service base? And you talked about plans of expanding your bay count. If you could put any specific numbers around that, and where you're trying to get that would be great.

Sure. Well, we report on this I think every quarter. We're at stall utilization now of about 65%, but our stall utilization in our luxury brands is almost 80%. That overall number is dragged down a bit by domestic. Where obviously overtime, units in operation have shrunk industry wide. Our utilization there is about 40%. In terms of stall for productive stall investment. We continue to invest in incremental stall capacity in those premium brands that have taken share over the last five-years and grown units in operation.

As we look ahead to '06, we are going to be building an additional 273 stalls, about half of that is pure incremental, and already on the calendar for '07-'08 are 334 new stalls, again, about half of which will be incremental. And as I highlighted earlier, we're seeing extremely robust growth in our luxury brand service departments, in fact, service gross profit in our luxury brands is up about 17% year-over-year and fixed absorption is over 100%. So again, while you're seeing our rent increase in the short term because of that investment, that investment is strategic. And that investment is being made in brands where we have the confidence that the strong double-digit growth will continue to fill those stalls and generate high margin revenue dollars.

I'm sorry, I apologize, this is the absolute last question. On these service bays as you're adding them, are they flat stalls or are you putting in tooling or do you just add the tooling as you move along and they-?

Well, obviously we add the tooling immediately. Where we have the demand to fill those stalls immediately. But in some cases, obviously, we're building for future growth and we don't make that investment in some of the FF&E until at which time we have demand to fill those stalls, but of the stall numbers that I gave you, over 90% of those stalls are able to be outfitted for full productivity. A handful of those stalls are flat bays or PDI bays or detail bays where we won't invest in the equipment to become fully productive.

Great. Thank you very much.

Thank you. John, I have one other follow-up for you. The differential in margin expressed as a percentage is about 8.5% for car and 6.5% for truck.

Fantastic, thank you very much.

Your next question comes from the line of Rick Nelson with Stephens.

Thank you and good morning.

Good morning, Rick.

You made several years of SG&A improvements. I'm wondering how much more opportunity you see out there and what will be the major drivers to that.

Rick we were just talking about that this morning, actually. And I continue to see a lot of opportunity. And probably in the neighborhood of one to 200 basis points. Probably over the next couple of years. And it comes virtually everywhere. Every cost element that we keep focus on, and as you know, our gross is driven up by our portfolio enrichment strategy. But I like to see both, I like to see the gross going up and I like to see the costs coming down, to me, that's a recipe for success. There's a lot of opportunity.

We looked at SG&A as a percent of gross for your import dealers compared to your domestic dealers, what sort of basis point differential might we save?

It's material, Rick. I can't put my finger --

I can follow up with you on that.

I've got those numbers for you, Rick. You're looking at a differential of somewhere around --10 basis points.

10 points.

10 points. That's 10 basis points. [overlapping voices] Differential is 10 percentage points and that's luxury to domestic, if you blended imports, it's about 800 basis points. Very very material obviously. And that highlights the validity of the portfolio enrichment strategy and certainly the continued focus on luxury brands with that 10 percentage point differential will also be a driver along with some of the margin and cost reduction opportunity that Dave highlighted.

Thanks. Just want to follow up on service and parts, if you could discuss differences between warranty and customer pay for the quarter?

I sure can. Quickly I had an ad hoc comment on the SG&A that you might find helpful while there is that big differential between our domestic and import SG&A, I should note that our domestic SG&A was down significantly as well about 250 basis points during the quarter, so we're improving operations across our brand mix. In terms of warranty versus customer pay. As I think all of our peers have reported, there is a decline in warranty work as a percentage. It was 22% of our total business going back. That's down about 7% to 19.7%. And that's really being driven by a couple things, one, '04 and '05 were record years for industry recalls, and secondly, as I think is widely documented in industry press, the quality continues to improve on vehicles across the board. And that is a contributor to lower warranty. We're very pleased with our CP trends. CP growth was about 11% year over year.

Thank you for that. And any comments on October, what you're seeing to date?

On October business trends?

Yes.

Well, I think it's important to dig deep into the numbers in October. Because sequentially, there is some weakness that's being reported in the industry. Year over year, I think the industry is going to report an increase. But that increase is against very, very weak comps, because of some of the pay back on the family plan a year ago, so I think on bias, there is some weakness in October. We don't have our final numbers yet obviously. But I think you'll also see that brand will continue to be very important, and that the luxury on import brands will clearly continue to hold up better regardless of any overall weakness in the marketplace.

Thanks, Jeff and Dave.

Sure, Rick.

Your next question comes from the line of Scott Stember with Sidoti & Company.

Did you guys give the percentage of your new stores which are running on the new used car initiative?

About 60%, and scheduled for completion the tail end of the first quarter of next year.

Okay. And I guess the only brand on the domestic side that you guys have significant exposure to is Cadillac. Could you maybe talk about how those stores are moving along?

Yes, I sure can, and we have exposure to -- Cadillac is about 50% of our general motors exposure, and our General Motors and Cadillac stores performed well during the quarter. In fact, they were up in terms of overall profitability. We like where we have domestic brands. We're heavily concentrated outside of Cadillac with Chevrolet and markets that have strong truck demand and overall domestic receptivity like Texas and Oklahoma. In terms of Cadillac, one of the characteristics that we really like about Cadillac is the strong fixed absorption. Our Cadillac stores enjoy fixed absorption in aggregate of about 90%, so that's a big driver of consistent profitability there. I'll also note the new Escalade remains a very hot model. We're pleased with the continued trends there. In fact, Cadillac is one of the few brands that has flat year-over-year truck sales as a result of the successful launch of the new Escalade.

All right. That's all I have. Most of my other questions have been answered already, thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of [Edward Uramo] with JP Morgan.

Hi guys. Most of my questions have already been asked, but can you give us an update on the status of your DMS conversion?

DMS conversion is underway. We're expecting it to be done about middle of next year.

Thank you.

Making good progress. Most -- we're in the investment stage now, I think most of the improvements in terms of how we manage the business and go after cost savings will come at the tail end of '07, early '08.

If I could chime in. This is Jeff. I think obviously, there's been a lot of discussion in the sector before how DMS could help us further reduce SG&A and certainly they'll be some efficiencies that will help us be more cost effective. Most of that in my view will come through productivity and efficiency increases with our associates but the piece that's often overlooked is we really view technology and our investment in that common DMS as a key driver of revenue and gross margin enhancement in the future through components like optimizing, inventory management, customer relationship management, Internet as well as electronic F&I menu, maybe even electronic desking, et cetera.

So as Dave noted it will be late '07 and '08 before we get the full benefit of that investment. But we look for it to come in a two-pronged fashion, both through revenue and margin enhancement, as well as some of the obvious efficiencies that will help us leverage cost.

Great, thank you very much.

Your next question comes from the line of Kelly Dougherty with Calyon.

Hi guys. Thanks for taking my question. Congratulations on the quarter. I have a quick follow-up on your acquisitions, I'm wondering you're solely focused on the nondomestic brands or would you be open to domestics in the right locations and I mean, domestics kind of outside of the Cadillac realm?

Yes, I'll take that question. As we've articulated, as a clear part of our strategy, we are targeting the luxury brands and the tier one imports, but we would not rule out a domestic acquisition that is strategic. Again, if we saw a compelling value proposition or it was a domestic brand that came available where we have a nucleus of dealerships and can get some regional synergies, then we would certainly consider it. We're going to evaluate those on a return basis and see how they compliment our overall portfolio. But again, we'd want to reiterate that our primary focus going forward is going to be to continue to acquire luxury brands, that's a core strength. For Sonic, we demonstrate our ability to operate those stores very successfully as well as the tier one imports like Honda and Toyota that are continuing to take share.

Great, thanks. And I just have one more. Last quarter you were talking about the opportunities you saw more towards the value end of the used vehicle spectrum. I'm just wondering you can give us a breakdown of the value vehicles, and I think you said the certified vehicles are about 33% of your total. I'm wondering if you have any targets for either of those segments that you're willing to share?

Well, we don't have a specific target. Those numbers will move around a little bit. For instance our CPO as a percentage is actually down somewhat as we put more emphasis on the lower cost of sale. But we have articulated and continue to focus on a dual strategy certified preowned in terms of our late model used car business, and trying to wholesale less cars and retail more to retail more of those lower cost value segment vehicles. The value piece has now grown to around 20% of our total business. That's a nice increase.

If you go back a year or two is about 21%. CPO usually runs between 33% and 38% of our total used car penetration, and that compares to a total industry certified preowned penetration of just less than 10%. So that's a part of the market where we've been active for many years. We think it's also been a driver of some of the great fixed operations trends that we continue to report as well. So we don't have specific targets there. We think there's growth opportunities in both segments.

Great. Thanks. Just one more. I'm just wondering if you could give us your new-to-used ratio?

Yes, Kelly, this is Dave, I was actually just going to mention that. We've made good progress with used sales but there's a lot of opportunity going forward. The Champion stores in the third quarter were at 0.49 to 1. And that's up from 0.45 a year ago. So almost a 10% increase there. But if you look at the industry overall. It's about 0.6. So that leaves us with 20% more upside in those stores. So, I'm still viewing that. Yes, we've made progress and yes, there's a lot more to come.

[overlapping voices] To further quantify that. If -- when we achieve parity with the industry peers at 0.6 to 1, that would result in 20,000 incremental used vehicle units for our company. So that's a huge opportunity. It's one that's too big to ignore and we're going to continue to focus on capturing that opportunity again. 20,000 incremental units. If we just move that ratio to our peer group average, and that's a challenge that we're looking forward to, and certainly the used car processes that we've implemented have shown positive trends toward that target.

Good luck with that. Thanks.

Thanks, Kelly.

Your final question comes from the line of Adam Franz with King Capital.

Yes, good morning, thanks for taking my call, guys. Jeff, I got a little mixed up in terms of the number of stalls, '07, '08 if you could repeat that, and then perhaps if you had any comments in terms of hiring competent mechanics how tough that market might be?

Sure, I'll be glad to. Again, for '06, we'll complete 273 new stalls, about half of those stalls are incremental. But the entire investment, obviously, not only gives us stall capacity, but in most cases is accompanied by better customer interface areas, so there's some incremental benefit there as well. Looking ahead to '07, '08 on our planning calendar. We already have an additional 334 new stalls, and about 185 of those stalls are truly incremental. In terms of technicians, I think it's widely reported and I certainly agree with industry perspective that one of the real challenges we have as an industry is going to be a shortage of qualified technicians as we go forward.

But we believe companies like Sonic have a competitive advantage. One because we're investing in state of the art facilities. Most of our shops now are air conditioned, which in and of itself is a competitive advantage to attract technicians, but obviously, we're able to offer a comprehensive corporate style benefits menu and a number of other advantages over a private kept dealer in attracting and recruiting those technicians. I should also note that we have an initiative underway, a collaboration between our human resources and fixed operations department. And we are now working with a number of vocational schools including the military and initiating alliances with those resources so that we can cultivate a pipeline of qualified technicians to fill those new stalls and generate that high margin revenue as we look to the future. And I think our results confirm that we've been successful at attracting technicians and taking advantage of that additional capacity.

Gotcha. Gotcha. Thank you very much.

At this time there are no further questions. Are there any closing remarks?

We just want to thank everybody for their participation in the call today. Thank you very much.

This concludes today's conference. You may now disconnect.